Warning that banks were likely to be the sector of the City hardest hit by Britain’s departure from the European Union, the IMF said the costs of doing business would rise and regulation would become more complex.

The half-yearly Global Financial Stability Report – one of the IMF’s two flagship reports – said the benefits of London as a global financial hub stemmed from economies of scale and its expertise across a range of industries.

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While the IMF acknowledged that there was “significant uncertainty” about the outcome of the two years of article 50 negotiations, it added that “the challenges stemming from Brexit could undermine financial stability in ways that are difficult to estimate or predict at this juncture.”

The IMF also noted that there could be financial stability benefits if Europe had a less concentrated banking system. The Washington-based organisation said global financial stability had continued to improve, helped by a pick-up in economic growth.

But it expressed concerns about the ability of heavily-indebted US corporations safely to fund higher investment during a period of rising interest rates. It also warned that a tightening of policy from the Federal Reserve, America’s central bank, or rising protectionism could add to the vulnerability of exposed firms in the emerging world, raising their debts by between $130 and $230bn.

The IMF highlighted China as its biggest concern among emerging economies, noting that bank assets were now more than triple the size of its economy. “China faces mounting risks to financial stability as credit continues to rise rapidly,” it said.

It said the economic recovery in the eurozone would not be sufficient to solve the problems of its “persistently weak” banks.

“System-wide headwinds are a problem not only within countries but can also affect the profitability of large, systemically important banks in Europe. These institutions find it difficult to keep up with their global competitors, and in some cases this may be partly due to profitability problems in their home countries.”

The IMF added: “Left unresolved, a combination of weak profits, lack of access to private capital, and large bad debt burdens impedes recovery and could reignite systemic risks.”

Some European governments use the City’s bond markets to raise money more cheaply than they could do at home, but the IMF warned that they could find it harder and more costly to do if business was moved out of London after Brexit.

The IMF said banks were likely to be the hardest-hit sector of the City, followed by insurance, with asset management firms least affected.

“Although there is a continuum of possible outcomes from Brexit negotiations, it is likely that financial firms’ ability to operate across jurisdictions will be curtailed to some degree,” the report said. Banking activities were likely to be the most affected by the loss of passport rights – which allow UK-authorised firms, banks and fund managers to conduct business in the other 27 states.

“Uncertainty about the negotiation outcome is pushing banks to anticipate Brexit-related costs,” the IMF said. “Banks have started preparing for a worst-case scenario, in which no agreement is reached, to avoid any possible disruption to their services. Duplication of some activities and business structures in different locations seems inevitable and represents an extra cost. Operating in different regulatory regimes will also increase the burden on banks.”

The IMF said the complexity of financial institutions was likely to increase after Britain’s exit from the EU, making life harder for national supervisors. “Even if there is a generous agreement on regulatory equivalence, the UK and other EU legal systems could start to evolve separately. Financial firms will be forced to develop new strategies for operating and competing in a reconfigured world, and business structures are likely to become more intricate,” it said.

Even though Britain is not a member of the single currency, the City has up until now been the place that “clears” trades in the euro by acting as a marketplace for buyers and sellers. This role is now under threat, but the IMF said that even if euro clearing and settlement remained in London, the burden on UK regulators would increase. They would have to “take over the regulation of rating agencies and trade repositories from the European Securities and Markets Authority. Such a task could amount to reviewing and revising thousands of pages of EU regulatory rulebooks.”